The Lure of Outsourcing in Accounts Receivable and Accounts Payable

The move toward widespread finance and accounting outsourcing (FAO) appears both undeniable and unstoppable. Numerous large corporations have already outsourced significant transactional activities. This activity has taken many forms and included both financial institutions and third parties – and often partnerships between the groups. Yet relatively few banks have accounts receivable outsourcing (ARO) or accounts payable outsourcing (APO) offerings beyond the staple wholesale lockbox and disbursement products. Those that do are glad they do.

Against the backdrop of FAO growth by third parties, along with its favorable client impact, banks would be hard pressed to defend inaction. Clearly nascent and not without challenges, APO and ARO represent strategic levers for cash management banks in the quest for revenue growth. Banks can choose to get involved, securing a more strategic position with clients, or relinquish the opportunity, leaving for themselves an increasingly commoditized payments business at the tail end of their client’s financial supply chain.

Celent encourages such forays into APO and ARO, as some early movers have already done, albeit in measured, incremental ways. A specific example is profiled later in this article. In contrast, full-scale FAO (e.g., outsourcing entire departments) should be left to the likes of Accenture and CapGemini.

A common challenge for banks seeking to field APO and ARO solutions is in developing adequate domain knowledge to get the product right the first time. While this may be a classic product development challenge, the way forward for banks doesn’t have to be overly difficult or risky. That’s because multiple solution providers are ready, willing, and able to engage in partnerships with financial institutions to deliver FAO solutions to the market. It is a win-win.

Celent recently interviewed banks, FAO providers, practitioners, and software venders to distill the opportunity and implications for banks in APO and ARO, offering these observations:

• APO and ARO are viable and logical extensions of existing cash management products up the financial supply chain. They are most effectively sold as such, rather than as an outsourcing solution.
• Done well, APO and ARO involve a skillful blend of enabling technology, business process reengineering, and selective outsourcing. Success requires client intimacy and thorough involvement in business process. A significant part of the value-add rests not with outsourcing per se, but in the vetting and reengineering of the client business process, with the skilled use of technology allowing the client to keep control. Pioneering banks attest that doing so requires a new type of sales effort: solution-focused, consultative, and protracted.
• For most banks, APO and ARO initiatives may be best launched through partnership with a third party firm specializing in these services.
• Sales cycles will be longer than those associated with traditional cash management products, and involve developing new client relationships beyond the treasurer.
• APO offers more promise in terms of net additional revenue than ARO. Several factors driving adoption favour APO. That said, many banks have a foothold in ARO-lockbox, and should explore logical extensions of those services, or risk continued marginalization.
• Operational synergies (e.g., using wholesale lockbox for invoice-to-pay solutions) may be an appropriate long-term objective, but it should not be an initial focus. The risk of disruption is too great.

The benefits to financial institutions of extending into APO and ARO are manifest, yet doing so will require some courage because it will not be easy. Demand for such services is growing, and moving solidly into the mid-market. But the opportunity does not resemble the tidal wave of remote deposit capture demand, for example, but more of a gently rising tide. Thoughtful action is warranted.

FAO: The Time Has Come

Finance and accounting outsourcing (FAO) is indeed an idea whose time has come. Increasingly, companies are looking for ways to bolster their bottom lines with cost savings and organizational efficiency gains. Meanwhile, many banks are facing stagnant cash management revenues, with little optimism for a sustainable rebound unless decisive action is taken. Activity is occurring on both the payables and receivables side, but the more significant opportunity may be in accounts payable outsourcing (APO) solutions.

• Payables: Invoice receipt and processing solutions. Often referred to as ‘reverse lockbox’, these solutions outsource invoice receipt, image capture, and processing, while allowing clients to maintain full control over disbursement decisions. Several banks have further integrated these solutions with payments processing to form an end-to-end payables automation solution.
• Receivables: Leveraging investments in image lockbox platforms to accelerate information delivery and provide higher rates of cash application. These efforts take the form of Web-based same-day decisioning of exception items and, in a few cases, more sophisticated AR matching capability. Both initiatives are designed to reduce the client’s reconciliation effort, while reducing days sales outstanding (DSO).

Why now? First consider the client perspective. While companies have been outsourcing bits and pieces of their finance and accounting function for 30 years, multi-process FAO is reaching the rapid growth stage, according to a September 2005 report by the Everest Research Institute. There are several factors:

• Cost pressures – Chief financial officers (CFOs), forced to cut costs to thrive or even survive, are increasingly using outsourcing to drive down the transaction processing costs of the corporate finance function.
• Compliance – CFOs have discovered outsourcing can help with compliance initiatives, an imperative now that section 404 of the Sarbanes-Oxley Act can send them to jail for false accounting. For that reason, visibility has risen to the highest levels for decisions that affect financial processes.
• Working capital – According to a 2006 study by The Hackett Group, the 2,000 largest global companies have in excess of US$1 trillion tied up in excess working capital. The opportunity for improvement in working capital management is significant, and not limited to the largest companies.

And, from the financial institution’s perspective, why now? What are the drivers?

• A disappointing cash management revenue picture – Although 2005 saw modest growth, fueled by rising interest rates and purchasing card transaction growth, the long-term picture suggests electronic payments revenue may not keep up with declining paper-based products. Banks have built value-added services around the check that generate fee income, in particular: controlled disbursement, positive pay, and positive pay plus (payee verification), and automated reconciliation.
• A ready image infrastructure – Truncation of paper is hugely enabling, and is becoming a catalyst for change. It enables dramatic changes in operations as well as information delivery and work process automation for bank clients. Since businesses show every sign of long-term paper addiction, banks would do well to find creative ways to leverage their image infrastructures to extract additional value.

• Sarbanes-Oxley legislation – Compliance concerns have given rise to broad based interest in accounts payable, and the compliance risk inherent in antiquated paper-based processes. The road to SOX compliance in many companies forced them to diligently document and map treasury policies and procedures.
• The search for ‘stickiness’ – Stickiness is an often-unstated benefit of outsourcing. People don’t like to move around systems and process relationships – if they’re working well. Outsourcing is inherently ‘sticky’ if the outsource provider is doing a good job.

• An evolving corporate treasury – Corporate treasury staff are performing more strategic duties while continuing their traditional cash management functions, and they are largely asked to do so without the benefit of additional staff. Many treasury departments are expected to contribute directly or indirectly to revenue and/or profit growth in their organizations. Further, financial professionals must serve their organizations while balancing the burden from additional attention given to compliance activities. The environment is favorable for financial institutions to leverage their existing treasury relationships with additional services.
• Supply chain financing opportunities – FAO can be a catalyst for creative financing opportunities. Supply chain financing rests on satisfying seller cash discount requirements. But for many companies still beholden to manual payables workflow, their long invoice-to-pay cycle times make supply chain financing impossible.
• Compelling synergies – Clients appear more than willing to trust their financial institutions with a larger piece of the pie. Once trustworthiness has been established, banks tend to be in a position of strength compared to third parties. Moreover, banks can leverage account analysis to deliver value in ways that third parties cannot.

Where to Participate

All manner of FAO services are being offered, from specialized processes such as collections or payroll management to complete outsourcing of entire payables or receivables functions. Some of these (e.g., collections) provide no obvious synergies with services financial institutions have historically provided. Other examples are close to where banks already play in the financial supply chain, and movement there can be considered a logical step. For example, Key Bank leveraged its roots in disbursements to move into payroll management and beyond. It is Celent’s view that such ‘incremental’ movement (versus the outsourcing of entire functional areas) represents the best near-term opportunity for financial institutions.

APO and ARO are both viable for incremental extensions of banks’ current services. Of the two areas, receivables offer the most logical place to start. Lockbox has been around for decades and has near saturation adoption. By providing lockbox services, banks have placed themselves well into clients accounts receivable work processes. Few banks, however, have ventured up the receivables side of the supply chain. In contrast, banks have not had a rich history of being connected with clients’ accounts payable – beyond payment origination. Yet comparatively more examples exist of banks successfully launching APO solutions. Why the apparent incongruity? Celent’s view is that it was banks’ relative absence on the payables side that invited innovation by third parties. In essence, banks are now in the position of having to play catch up. In contrast, banks have long since ‘owned’ the wholesale lockbox environment. Figure 1 shows examples of incremental (or specialty) FAO services in a financial supply chain context.

Figure 1: Specialty Versus General FAO Examples

How to Get Started

Three obvious options exist for financial institutions seeking an expanded participation in clients’ financial supply chains: go it alone, partner with a third party, or acquire an existing FAO provider. Several well-known examples are listed in Table 1.

Arguments can be made for two of the three options. Going it alone, however, would prove difficult unless the initial solution scope was purposefully narrow (e.g., invoice capture) and closely tied to a bank’s core competency (e.g., lockbox). Here’s why:

• Faster time to market
• Access to domain expertise – Excelling in FAO demands a new expertise of aspiring banks. From interviewing multiple FAO providers, Celent concludes that excellence results from uncovering and operationalizing a myriad of business rules buried deep in the client. Doing so requires a disciplined, multi-day requirements gathering process. A typical organization of US$800m in revenue might have 5,000 employees in 30 locations. Most don’t have well-documented processes. There will be significant internal disagreement, assumptions, and informal ‘that’s the way we’ve always done it’ arguments heard as solutions move through implementation. FAO providers must skillfully discover, vet, reengineer, and operationalize new business processes – with the full consent of the client.
• Difficult business case justification (capital and project expense) – Entry into FAO requires significant investment in systems and infrastructure. Coupled with the long sales cycles cited by veteran FAO providers, the investment suggests a challenging ‘go it alone’ business case.
• Complex implementation – FAO solutions are inherently complex. This creates a need for rigorous project management methodologies and ongoing subject matter expert involvement throughout the project. Implementations are lengthy, 12 weeks or longer. Early mover APO banks, for example, initially relied heavily on partner-led implementations as a result.